Screwdrivers and Scroll Saws: Using Advanced Order Types

Success in almost any profession requires familiarity with a basic set of tools. For the carpenter, it’s the hammer, saw, and screwdriver. The artist must know how to use brushes and pigments to make a canvas come alive. Even scientists rely on tools like formulas, spreadsheets, and computer modeling to prove their theories. And when it comes to trading, order types—from simple to complex—are some of the most important tools in your toolbox.

Many traders spend considerable time and effort selecting trade entry and exit points. Selecting the appropriate order type can potentially help you hit those entry and exit points. So let’s take a look at some of these trading tools, from the basic hand-helds to the complex power tools.

Tools for Basic Construction and Maintenance

Market order: A market order is the most basic order to buy or sell. It’s executable as soon as possible once it’s submitted. This type of order is designed to execute at whatever price the “market” is trading, and there’s no guarantee at what price you’ll get filled. The idea behind a market order is to fill as fast as possible, with little or no concern for a "good price."

Stop order: A stop order (also called a “stop-loss order”) is a market order in a suspended state that will be activated once a trigger price is hit. It’s commonly used to protect an open position from additional losses past a certain point. A stop-loss sell order is placed below the current price of a long position or above the current price to close a short position. Although a stop order is designed to help protect a position from further losses, it becomes a market order once it’s triggered, so there’s no guarantee the order will be filled at or near the stop order price.

Limit order: A limit order is an active order designed to buy or sell at a specific price or better. A limit buy would be placed below the current price of a stock to initiate a long position; a limit sell would be placed above the current price to initiate a short position. Limit orders will only fill if the price moves in your favor.

Tools for Flexibility

If basic orders are the wrench and screwdriver of the trader’s toolkit, these order types, which add contingencies and other complexities, would be the trader’s variable-speed scroll saw—designed for flexibility.

Stop to open: Although most commonly used to close out a position, a stop order can be used to open one as well. To initiate a long position, the buy stop order is placed at a price above where the stock is currently trading. If the price is hit, the order immediately converts to a market buy order.

This type of order can be effective when looking to buy a stock on a breakout above a resistance level or technical indicator. A sell stop can be used in the opposite way to initiate a short position.

Stop-limit to open: In this case you would essentially add a limit order to the buy stop, which, as the name implies, limits the price you would be willing to pay for a stock once the stop price is hit. This order converts to a limit order instead of a market order upon being triggered.

For example, if a stock is trading at $49 and you want to buy it if it breaks above $50, you could put in a buy stop order at $50.05. But if the stock opened at, say, $55 (a “gap open” in trader-speak), your order would be triggered and convert to a market order, meaning you could potentially be filled almost $5 above your intended price.

Instead, a stop-limit order could be placed with the stop at $50.05 and the limit at $50.10, meaning that no matter what price it opened at, you would only be filled at $50.10 or less. The opposite of this would apply for a stop-limit sell order, which would initiate a short position.

The risk, of course, is if the stock gaps higher on the open and doesn’t pull back, you will have missed the entry point entirely.

Fill or kill/all or none: The fill-or-kill (FOK) order is a combination of two other order types, Immediate or Cancel (IOC) and All or None (AON). It's designed to be executed in full, within a virtually instant time period, and canceled if not filled. An all-or-none (AON) must be filled completely when executed, or it’s not filled at all. Partial fills are not allowed. For example, if you’re bidding for 1,000 shares at a specific price, and there are 900 shares offered at the same price, your order will not be filled. Unlike the FOK order, the AON stays active until you cancel the order.

While FOK and IOC orders do not see much use today, the AON remains relevant to more than a few traders. Here's why: a limit order experiencing several partial fills in a day will incur one commission, while a limit order that partially fills one day, with the balance filled the following day, will incur two commissions. If it takes three days to fill completely. it will incur three commissions, and so on. Thus, among traders looking at good till canceled limit orders, the AON order may still have some fans.

One cancels other: Also known as an OCO, one-cancels-other orders are less well-known than other order types, but many traders view them as among the most powerful and flexible complex order types.

An OCO order is best thought of as a strategy, because it is made up of two separate orders on the same stock that are independent, but linked to each other. Suppose you hold a long position in XYZ, it’s currently trading at $50, and you’ve identified a target price of $55, but if it falls to $49, you want out. You could create an OCO composed of a stop order (or stop-limit order, depending on your strategy) at $49 and a limit order to sell at $55.

Once you place the order, there’s nothing more for you to do, unless your objectives change and you’d like to change one or both of your targets. If the stock trades to $55 and you get filled on the sell limit order, your stop order at $49 will automatically be canceled. Conversely, if your stop order is triggered, your sell order at $55 would automatically be canceled.

One cancels another: Referred to as an OCA order, this is different from an OCO in that it’s placed alongside a separate order—or group of orders—and the first order that’s triggered cancels all others.

Suppose you were considering buying two different stocks on pullbacks. You could put a limit buy in on both stocks as OCA orders and then let the market make the choice for you. The first stock that pulled back to your limit price would be bought, and the other limit order for the second stock would automatically be canceled.

Not every trader will need to use complex orders, but it might be a good idea to familiarize yourself with all the different tools at your disposal in order to give you the most flexibility when designing your trading strategies.

Knowledge: An Important Tool

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A trailing stop or stop-loss order will not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

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Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

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